Why Brazil is becoming a global hub for tech investments

Latin American tech startups benefitted from1,251 funding rounds for a total of US$12bn in investments last year, according to a joint report from Brazil's Itaú BBA and Sling Hub. The investment volume was down 34% from 2021.

“With higher interest rates and inflation levels impacting liquidity, the result was more constrained valuations, longer and more difficult due diligence processes, fewer unicorns, and an overall feeling of caution,” reads the report.

In an interview with BNamericas, Itaú BBA  managing director Thiago Maceira talks about the 2023 outlook for the tech-focused venture capital segment.

BNamericas: What would you highlight as most relevant in the report in terms of trends?

Maceira: There are two ways of looking at the data of 2022. When we think of the evolution in a sequence, last year's numbers are obviously much weaker than those of 2021. But taking a longer view, you will see that 2022 was relatively strong regarding fundraising. 2021 was an off-chart year in terms of liquidity.

And this was due to a combination of several already known factors. First, we had a very strong acceleration of digitization in Brazil and Latin America as of 2020, with the pandemic. This attracted a lot of attention from global funds, and excess liquidity meant that these funds had a lot of capital to invest. 2021 came as the perfect storm of it all.

But even so, in 2022 we had a good financial flow and a very large number of transactions, which shows that the region's ecosystem is much more mature and stronger than in the past.

Also, the big slowdown we had was across the board but much more so in those late-stage and pre-IPOs companies. These suffered much more. In some cases, the drop [in funding] reached 60%. Bigger companies, which needed much bigger checks, suffered the most.

BNamericas: What would you attribute that to?

Maceira: Many of these companies were B2C companies, which grew too much during the pandemic. They invested a lot to meet demand. But then with the particularities of B2C, the cash burn, the need for investment to continue growing, this thesis became a little more difficult in the market.

And also because these companies were perhaps closer to an IPO. With a slightly more reticent market, the funds decide to hold back.

In the early-stage segment, there was also a drop, but less relevant.

Now, in terms of quantity and diversification of funds, 2022 was an important year. We continue to have new funds looking at and investing in Brazil. This is further proof that Brazil is becoming one of the hubs for technology investment in the world.

BNamericas: There was also growth of domestic funds, wasn't there?

Maceira: The diversification is global. Today there are many more family-offices, local funds, private equity funds, which are learning about and wanting to participate more and more in this digitization [process].

BNamericas: And regionally, how do these investments fit in?

Maceira: When you compare LatAm against Brazil, Brazil remains super relevant. But we’re beginning to see these investments emerging more strongly in other markets in the region. This is very much related to the level of digitization. Brazil is much more advanced in this sense than its regional peers, mainly in South America.

As other countries move forward on this path, so do investments. We've seen increased participation from other markets as well, there's a lot of interest, unicorns popping up in different countries.

But, again, Brazil should continue to be the great regional technology hub due to the size of its economy, the degree of digitization and even cultural aspects related to the incorporation of technology in everyday life.

BNamericas: Some analysts point out that there has been an accommodation to healthier levels in terms of valuations of technology companies. Do you share this view, or do you believe it is more of a constraint on investment given the macroeconomic context and higher interest rates?

Maceira: There was a global review on how the market assesses the growth and potential of these digital and ‘exponential’ companies. 

But it's not that investors are no longer looking for accelerated growth. They are looking more towards self-sustaining growth. In the last three, four years, a company that grew 300% was seen more favorably than one that grew 50%. Even if the former needed capital every six months.

One of the reasons for this is that capital was abundant. No one thought they didn't have a chance to raise funds every six month. Once capital becomes one of the restricting assets, investors look at companies and start demanding that they are in fact profitable, self-sustaining. The prospect of less abundant capital made companies and investors reassess their ability to grow. It’s a rebalancing of the financing equation of growth plus profitability.

But another factor that affected the entire market, and not just technology, is that today we have a new level of interest rates in the world. All assets, whether it's real estate, retail, infrastructure, with the higher interest rates, the discount rates get higher. And the intrinsic value of companies tends to fall.

In a technology company most of the value is in the future, which is when they will generate cash flow and be more profitable. If the interest rate goes up, you discount the present value, and these future cash flows go down.

But having said that, if you have a company that is ‘self-funding’ and growing at 300%, investors are still going to pay 15, 20, 30 times revenues.

BNamericas: What’s your outlook for this year?

Maceira: We’re optimistic about what will happen in the ecosystem. Leaving valuation and interest rates aside, we’re in the middle of the digital transformation process in Latin America and in Brazil.

We had a very strong acceleration in the pandemic, but there’s still much room to grow, especially in digitization and services for small and medium-sized companies.

And when we look at the performance of these technology companies in Brazil, they continue to grow strongly, delivering products, having an impact on the economy. E-commerce companies, software firms that are impacting the real economy and growing at very good rates. Global investors are looking at this a lot. 

The interest in Brazil, even in a relative way, is even higher I’d say. Because compared to some other regions there’s growth, the economy is large and needs innovation to become more productive and to improve efficiency.

What we see for this year is an interest in B2B companies, with investments in the late stage, or growth-stage companies, slowly returning as the market stabilizes.

Another trend is M&A. As these tech companies become bigger, it's natural for them to come together and consolidate. And companies that were not born in the digital world also see acquisitions as an opportunity to try to acquire competence and staff for the development of a digital product.

BNamericas: I take it you speak with knowledge of the facts? Itaú BBA is advising companies in these processes.

Maceira: I can't talk about deals or names, but it's something that should happen. I would be surprised if 2023 doesn’t turn out to be a good M&A year.

BNamericas: Will the window for IPOs reopen this year?

Maceira: There’s a special moment in Brazil due to the perception that interest rates and inflation are increasingly under control. Our interest rate cycle is probably at an end. 

We’re going to have a year in which Brazil grows again, albeit in a moderate way. The stock market seems already to be on the way towards stabilization.

As we get more visibility on the government's economic policies, this tends to provide more clarity for the market.

The US is still a little bit behind us in the interest rate cycle, but everything indicates that the hiking process there is also coming to an end. With all this underway, the scenario for the stock market should improve.

Now, historically, this recovery of the stock market comes first with follow-on transactions [rather than IPOs] because they are already listed companies, with a shareholder base. 

All in all, we continue to see international investors with a lot of interest in Brazil.